If you are like most professionals, you’ve most likely worked for more than one employer during the course of your career. While job-hopping was once a frowned-upon activity, it was also easier to assume that hard work and dedication to one employer would set you up for a comfortable retirement.
These days, with pensions a rarity and opportunity for salary growth often coming from a move to a new company, it is neither uncommon nor the subject of much stigma to be employed by many different firms throughout your working years. It is also not uncommon for professionals to take advantage of their employer's 401(k) plans, often with contributions matched up to a set level. Unfortunately, many people aren’t aware of all of their options when changing employers, as this event necessitates deciding what to do with your 401(k) from the firm you are departing. (For related reading, see: The Conflicts of Interest Around Your 401(k).)
When you leave a company at which you participated in a 401(k) plan, you have four options to consider.
Parsing Out Your 401(k) Options
- Cashing out your 401(k). If you cash out, you will be subject to taxation on all of the contributions you made to the plan, as well as an early withdrawal penalty. The combination of these two factors can reduce the overall value of your invested money by nearly 50% in some circumstances, and unless you are facing a true emergency, this should most likely not be the choice you make.
- Leaving your money where it is, in your old company’s 401(k) plan. This may be a fine option, but it does potentially have drawbacks. For example, if you leave the firm that offered the 401(k), you will almost certainly not be eligible for matching contributions, since you will no longer be an employee of the participating company. Regardless, this is a very common choice, and individuals who take advantage of career opportunities with several employers throughout their lifetimes often wind up with numerous 401(k) plans from numerous prior employers. Sound familiar?
- Rolling your 401(k) from your prior employer into a qualified plan offered by your new firm. This option may seem attractive, especially if your new employer matches contributions to the plan up to a set amount, but investment options available in a 401(k) are typically somewhat limited. Also, 401(k) plans can carry higher fees than other investment options—fees that reduce the impact of your contributions, as well as those made by your employer. Of note, any initial rollover amount won’t be matched by your employer. They may offer a contribution match up to a set percentage of your new salary, but that would only apply to future contributions from your regular paychecks, not any amounts you roll into their plan from prior investments.
- Executing a trustee-to-trustee transfer, commonly known as a rollover, into an IRA. A rollover IRA allows you to transfer your retirement funds from one or more prior 401(k)s into an investment plan with potential strategic advantages. You can open an IRA for the purposes of a rollover if you don’t already have one established, or you can also roll over your old 401(k) funds into an existing IRA. You cannot combine traditional IRA and 401(k) funds with Roth IRA and Roth 401(k) funds, however, so make sure you know the specifics of each of your investment plans before considering a move. Also, you may only execute one rollover per 12-month period between multiple IRAs that you own; however, this rule does not apply to a significant number of circumstances, such as rolling 401(k) plans into IRAs or executing trustee-to-trustee rollovers in which you do not personally take distribution of any funds. This means that you are able to roll multiple 401(k) plans into a single IRA within the same 12-month period, enabling you to compress the timeline of this process significantly if you elect to make this decision. (For related reading, see: 5 Investment Mistakes You Might Be Making.)
Rollover IRAs can offer several potential benefits, some not available through 401(k) plans. First, a rollover from one or more 401(k) plans into an IRA continues the deferral of taxation of your retirement contributions enjoyed when they came from your salaries at prior employers. Although you are obligated to report rollovers of this nature to the IRS, a properly executed rollover does not carry tax consequences on its own, as the funds are transferred between retirement plan custodians rather than being distributed, even if only temporarily, directly to you. If you were to elect for distribution to yourself and then put your funds into an IRA on your own, you would have 60 days from the date of withdrawal to deposit them into an IRA—although certain conditions now make you eligible for a waiver of the 60-day limit by the IRS.
If you do opt for a distribution to yourself, this is considered an IRA transfer, not a rollover, and although the difference may seem somewhat academic, the tax consequences of each option differ significantly from one another. If your intent is to simply move funds from your old 401(k) plan or plans to an IRA, a rollover is likely to be your best option thanks to its favorable tax treatment. (For related reading, see: Common IRA Rollover Mistakes.)
The second benefit of rolling your old 401(k) plan or plans into an IRA is the amount of money you pay in fees. 401(k) plans sponsored by employers may carry higher administrative fees than IRAs, and while fees associated with 401(k)s don’t negate your contributions outright, reducing the cost of your investment plan’s fees means more of your money goes to your retirement fund without additional contributions from you.
Third, IRAs tend to offer many more potential choices for how to invest your money than you would have access to with a 401(k). While employer-sponsored 401(k) plans do provide a suitable number of investment options, you are only able to choose from what your company and the custodian of your 401(k) plan offer to you. A rollover IRA allows you to allocate your money in many mainstream investments, opening up a wide array of options you would not have access to via your company’s 401(k). Since balancing (and rebalancing) your portfolio to keep it in line with your goals, risk tolerance, and time horizon is a process which is likely to change in nature as you age, a rollover IRA allows you to make new choices rather than stay with the ones you made when setting up your 401(k)s at prior employers.
The fourth benefit rolling your old 401(k) plan or plans into an IRA offers you is simplicity; instead of monitoring your investments through myriad account statements and/or online portals, a rollover IRA gives you the ability to keep tabs on your investment plan through a single statement or online tool set. This can be extremely helpful, as making future decisions about your retirement fund may involve complex calculations that only get harder when you need to analyze multiple accounts in order to see the bigger picture.
If you are considering a new job or have recently accepted a new offer, this is a great time to take another look at your retirement planning options. Depending on your individual circumstances, rolling your old 401(k) plan or plans into an IRA may be a good choice for you. (For related reading, see: A Rollover Mulligan for Your 401(k) Distribution.)